How Inflation can Affect Your Retirement Planning

With the economy the way it is, many people are becoming increasingly concerned at how inflation can affect retirement planning. And they are right to be worried, as the rate of inflation will affect how much an individual’s retirement savings will be worth in the future.

Inflation has the potential to devalue savings and reduce income in retirement. This is why it is vital to factor inflation into any retirement planning strategy.

How does inflation affect retirement savings?

Inflation is part and parcel of life. But whereas we can usually cope with smaller rises over time, during periods of rapidly increasing inflation where prices escalate quickly, it can be difficult for those on a fixed income to get by without making a significant adjustment to their spending.

It can also be difficult for those planning their retirement, because spending more just to live everyday can impact on how much you have to put away for your future.

In some cases, where inflation has risen considerably, it can be tempting to reduce retirement savings, and / or push back your retirement date.

But in reality, that strategy is probably the least sensible. The better option is accounting for inflation in retirement planning as early on as possible, and factoring in the potential for higher rates of inflation during the savings period.

How to account for inflation in retirement planning?

The UK government targets a yearly inflation increase of 2%. However, inflation is hard to predict, and it is not uncommon to see it rise much higher than the average.

When accounting for inflation in retirement planning, a good approach is to think about what sort of lifestyle you desire when you get there. This will inform how much you will generally spend. Once you know this, you can begin to calculate how much you will need in retirement, accounting for inflation.

For example, say you wanted to spend £50,000 per year in retirement based on today’s prices. Based on a 2% inflation rise, next year, that would cost you £51,000, and in five years’ time, it would be £55,204.

Therefore, by planning your expenditure based on your desired lifestyle, you will have a clearer picture of how much you will need to save when accounting for inflation.

How to protect against inflation in retirement?

Inflation is a financial risk that can never be completely avoided. Couple this with the fact that the majority of retirees have limited flexibility when it comes to combating inflation due to their fixed income streams, and it is clear to see why those planning for retirement have cause for concern.

However, it can be managed with a balanced strategy. And in terms of saving for retirement, there are numerous options.

Leaving your money in a savings account with a low interest rate is probably one of the least astute of these options, as the money is not likely to outgrow the rate of inflation.

Investing, on the other hand, can be a good way to protect against inflation in retirement. However, taking advice from a financial planner is essential to make sure this is the correct strategy for you based on your goals, that your attitude to risk is carefully managed, and that your asset portfolio is sufficiently diversified to balance your risk.

It may be possible to avoid any potential losses to retirement savings by investing in a portfolio that will outperform the rate of inflation. For example, investing in equities, bonds or stocks which would average a better return than leaving all your money in a low-interest rate account.

It is vital, however, to appreciate that there are risks involved with any type of investment, and no investment will offer a guaranteed return.

How much money could I potentially lose in retirement due to inflation?

Because inflation reduces the spending power of money, it also reduces the return on investments and savings.

Say you invest £100,000 which grows by 6% per year. This means you would have £106,000 at the end of the year. However, if inflation is 2% that same year, the real return is just 4%. So your £106,000 now only has the spending power of £104,000 compared to the previous year.

If the return on your funds is less than inflation, then your actual return will be negative. So for example, if you are earning 0.5% on your cash savings, and inflation is 2%, then your actual return is -1.5%. This means your spending power is reduced by 1.5% compared to the previous year.

Providing your retirement income and savings grow at least in line with inflation, then you should not lose any of your money’s spending power.

Looking to discover how inflation can affect retirement planning? Talk to the specialist retirement planners at PMW.

At Partridge Muir & Warren, we have been advising clients on their retirement options for over 50 years. Our advice is independent, widely trusted and fully focused on the best interests and personal objectives of our clients.

If you would like to learn more about how our strategies factor in accounting for inflation in retirement planning, why not get in touch with our friendly retirement planning team, and arrange your no-obligation complimentary consultation?